Unlike when you purchase an insurance policy, a surety bond is not something you pay monthly premiums on in exchange for coverage. Instead, a surety bond is a one-time, lump sum payment that acts as an agreement between three different parties.
If you or your business violates the contract of a bond, however, it’s likely that you will not receive any money back for the bond you paid.
Who Pays for a Surety Bond?
For the majority of bonds, the entity that need the bond for work (called the obligee) must purchase the surety bond. The amount you will pay for a surety bond depends on the contract, project being bonded and the surety. The surety is the entity that provides surety bonds. They will quote you (the obligee) depending on the project size and value.
When an obligee purchases a surety bond, it is typically an agreement that they will perform work in accordance to a contract with the principal (often the client or entity that requires the surety bond). If the obligee fails to complete the task according to the agreement, the surety will step in to pay for claims or expenses related to the obligee’s failure. The obligee will then be responsible for reimbursing the surety for claims paid.
Example 1
Say you run a construction business. You are hired by the local government to renovate a park. You agree on a contract to finish the renovations within a month.
While working on the project, a bad storm sweeps in and ruins your equipment left overnight. Due to recent setbacks and without insurance, you can’t afford to replace your equipment to complete the project in time.
The surety will then step in to either replace the equipment or hire another construction company to finish the job. Whatever the surety pays in order to guarantee the job is finished, they will then seek compensation for from your construction business.
Example 2
You are opening a restaurant that serves alcohol and must acquire a liquor license bond. A liquor license bond is also known as a type of compliance bond. This guarantees that the one who holds the license will abide by all of the liquor laws and regulations set forth by the state. You obtain a liquor license bonds and must maintain it in order to operate legally.
Then, the state discovers that one of your managers has been filing the liquor taxes incorrectly, costing the state money. Since this violates the bond, the state can then cancel your license and pursue legal action. In this case of a broken bond, you will not receive any compensation. If the surety is forced to pay the missing taxes, they may then seek compensation from your restaurant.
Example 3
As a contractor, you purchase a maintenance bond in order to protect your client from faulty workmanship during a period of time after a project is completed. The maintenance bond covers the work you have done on the client’s vacation home so that if any mistakes were made, damages will be covered by the surety. Two weeks after the project is completed, a faulty screw causes the pipes in the vacation home’s bathroom to burst and causes damage to the floor and cabinets. Through the bond, the surety will help pay for these damages. As the contractor, you can still be held responsible for the incident, however.
What Happens if Someone Else Cancels the Bond?
In some cases, the principal may cancel the bond before a project begins. Unfortunately, you likely won’t receive your money back for this surety bond. The same applies to other bonds. Say you purchase a liquor license bond for your restaurant. Your restaurant falls on hard times and you decide to no longer serve alcohol. You cannot receive your money back for the liquor license bond you purchased. This is similar to most insurance policies where you cannot receive money back even if the policy is cancelled.
How Much is a Surety Bond?
The cost of surety bonds vary wildly depending on the type of surety bond, the industry and the value of the project. A surety will quote an obligee with a percentage of the bond. For example, if you are quoted to pay 3% of a $60,000 policy, you will pay around $1,800 for the surety bond.
Keep in mind that surety bonds are not the same as insurance policies. Many businesses and professionals need both in order to safely operate. While a bond primarily protects clients and other entities, insurance protects you and your business in case of lawsuits, property damage and more.